Elasticity of Demand: Price, Income and Cross Elasticity (Measurement and Business Uses) Questions

Q: What is cross elasticity of demand?

**Cross elasticity** measures change in demand for one good due to a change in the price of another good.

Q: What is income elasticity of demand?

**Income elasticity** measures the responsiveness of demand to a change in consumers’ income.

Q: Give one example of a substitute good pair.

Example: **tea and coffee** are substitutes.

Q: Explain types of price elasticity of demand (any four).

Types of price elasticity (any four): - **Perfectly inelastic**: Ed = 0 (quantity does not change). - **Inelastic**: 0 1 (large quantity response). - **Perfectly elastic**: |Ed| = ∞ (very sensitive demand). Thus, elasticity varies from zero to infinity depending on responsiveness.

Question 1

Define price elasticity of demand.

Accepted Answer

**Price elasticity of demand (PED)** measures the responsiveness of quantity demanded to a change in the price of a good.

Question 2

Write the formula for price elasticity of demand (percentage method).

Accepted Answer

Formula (percentage method): Ed = (%ΔQd) / (%ΔP)  (often taken in absolute value for comparison).

Question 3

What is meant by inelastic demand?

Accepted Answer

Demand is **inelastic** when quantity demanded changes less than proportionately to price change, i.e., 0 < |Ed| < 1.

Question 4

What is cross elasticity of demand?

Accepted Answer

**Cross elasticity** measures change in demand for one good due to a change in the price of another good.

Question 5

What is income elasticity of demand?

Accepted Answer

**Income elasticity** measures the responsiveness of demand to a change in consumers’ income.

Question 6

Give one example of a substitute good pair.

Accepted Answer

Example: **tea and coffee** are substitutes.

Question 7

Explain types of price elasticity of demand (any four).

Accepted Answer

Types of price elasticity (any four):
- **Perfectly inelastic**: Ed = 0 (quantity does not change).
- **Inelastic**: 0 < |Ed| < 1 (small quantity response).
- **Unitary elastic**: |Ed| = 1 (proportionate change).
- **Elastic**: |Ed| > 1 (large quantity response).
- **Perfectly elastic**: |Ed| = ∞ (very sensitive demand).

Thus, elasticity varies from zero to infinity depending on responsiveness.

Question 8

Explain factors affecting price elasticity of demand (any five).

Accepted Answer

Factors affecting price elasticity (any five):
- **Availability of substitutes**: more substitutes → more elastic.
- **Nature of good**: necessities → inelastic; luxuries → elastic.
- **Proportion of income spent**: higher share → more elastic.
- **Time period**: long run → more elastic than short run.
- **Habit/addiction**: habit goods often inelastic.
- **Number of uses**: more uses → more elastic.

Hence, elasticity depends on consumer choice and adjustment possibility.

Question 9

Explain income elasticity of demand and its interpretation (normal vs inferior goods).

Accepted Answer

**Income elasticity (Ey)** measures how demand changes with income.

Interpretation:
- **Ey > 0**: **normal goods** (income ↑ → demand ↑).
- **Ey < 0**: **inferior goods** (income ↑ → demand ↓).
- **Ey > 1**: luxury-type normal good (high sensitivity).

Thus, income elasticity helps firms plan product mix for different income segments.

Question 10

Explain cross elasticity of demand and the sign for substitutes and complements.

Accepted Answer

**Cross elasticity (Exy)** measures change in demand for X due to price change of Y.

Signs:
- **Exy > 0 (positive)**: goods are **substitutes** (coffee price ↑ → tea demand ↑).
- **Exy < 0 (negative)**: goods are **complements** (petrol price ↑ → car demand ↓).
- **Exy ≈ 0**: goods are unrelated.

Hence, cross elasticity indicates competitive relationship between products.

Question 11

Explain why demand for necessities is usually inelastic (any three reasons).

Accepted Answer

Demand for necessities is usually **inelastic** because:
- there are **few or no close substitutes** (hard to switch).
- consumers must buy minimum quantity for basic use (cannot reduce much).
- the item often takes a **small share of income** (price change does not affect budget strongly).
- in the short run, habits and immediate needs reduce responsiveness.

Thus, quantity demanded does not change much even if price changes.

Question 12

Explain elasticity and total revenue (TR) relationship (use a table).

Accepted Answer

Total revenue: **TR = P × Q**.

| Demand type | Condition | If price falls | If price rises |
|---|---|---|---|
| **Elastic** | |Ed| > 1 | **TR increases** | TR decreases |
| **Inelastic** | |Ed| < 1 | TR decreases | **TR increases** |
| **Unitary** | |Ed| = 1 | TR constant | TR constant |

Thus, elasticity guides pricing decisions for revenue improvement.

Question 13

Define elasticity of demand and explain price, income and cross elasticity (exam-style with table).

Accepted Answer

### **Elasticity of Demand (Meaning)**

Elasticity of demand measures the responsiveness of quantity demanded to changes in price, income or related goods’ prices.

| Type | What changes? | Formula (percentage) | Business meaning |
|---|---|---|---|
| **Price elasticity (PED)** | price (P) | Ed = (%ΔQ)/(%ΔP) | pricing and revenue decisions |
| **Income elasticity (YED)** | income (Y) | Ey = (%ΔQ)/(%ΔY) | product planning by income groups |
| **Cross elasticity (XED)** | other good’s price (Py) | Exy = (%ΔQx)/(%ΔPy) | competitor/substitute analysis |

**Key points**:
- PED is generally negative (inverse price–demand relation).
- YED positive for normal goods, negative for inferior goods.
- XED positive for substitutes and negative for complements.

Thus, elasticity helps managers forecast demand response and choose better pricing and product strategies.

Question 14

Explain methods of measuring price elasticity (percentage, point, arc) with a simple flow/table (exam-style).

Accepted Answer

### **Measurement of Price Elasticity of Demand**

| Method | When used | Formula (basic idea) |
|---|---|---|
| **Percentage method** | when percentage changes are available | Ed = (%ΔQ)/(%ΔP) |
| **Point elasticity** | at a specific point on a demand curve | Ed = (dQ/dP) × (P/Q) |
| **Arc elasticity** | between two points (finite change) | Ed = (ΔQ/ΔP) × (P1+P2)/(Q1+Q2) |

```text
Small/percentage change → Percentage method
Specific point on curve → Point method
Between two points → Arc method
```

Thus, the method is selected based on the nature of data/price change, and it helps quantify demand responsiveness for pricing decisions.

Question 15

Explain business uses of elasticity of demand with examples (exam-style).

Accepted Answer

### **Business Uses of Elasticity of Demand**

Elasticity helps managers predict how customers respond to changes and supports better decisions.

**Uses (write any five):**
- **Pricing decisions**: if demand is elastic, a price cut may increase **TR**; if inelastic, price increase may raise TR.
- **Sales and revenue forecasting**: estimate how demand will change with price/income shifts.
- **Product planning**: income elasticity identifies luxury vs necessity segments.
- **Competitive strategy**: cross elasticity shows how close a competitor’s product is (substitute strength).
- **Tax impact and policy**: firms assess impact of taxes on demand; governments tax inelastic goods for stable revenue.
- **Marketing decisions**: helps decide where promotion can effectively shift demand.

```text
Estimate elasticity → Decide price/strategy → Predict demand & revenue → Implement → Monitor
```

Thus, elasticity is a practical tool that links market behaviour to pricing and planning decisions.

Elasticity of Demand: Price, Income and Cross Elasticity (Measurement and Business Uses)

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